A closer look
at commercial banks operating in Pakistan reveals some emerging trends.
The nationalized commercial banks (NCBs) are going through extensive
restructuring programme. Private banks are consolidating their position
by increasing their paid-up-capital and expanding branch network.
Foreign banks are selling their operations to local banks and taking an
exit from Pakistan. Are the conditions not conducive for foreign banks
for operating in Pakistan? Or, the higher profit made in the past was
only because of the inefficiency of local banks?

To explore this one has to look at the shift in
paradigm in Pakistan's commercial banking sector. The process was
initiated in early nineties with the privatization of Muslim Commercial
Bank (MCB) and Allied Bank of Pakistan (ABL) and establishment of a
dozen banks in the private sector. This was followed by the first phase
of financial sector reforms. Now the consultations with banks is going
on to initiate the second phase . The local banks have been asked to:
raise their paid-up capital to one billion rupee, follow maximum
disclosure requirement and make full provisions against non-performing
loans (NPLs). Efforts are also being made to restructure NCBs for their
ultimate privatization. All these measures have changed the working
environment. The local banks have emerged strong competitor of foreign
banks. Have the foreign banks lost the zeal to compete or do they find
themselves inadequate to compete with the local banks?

Foreign banks operating in Pakistan have thrived in
the past mainly due to selective clientele, better standard of services
and virtually no burden of NPLs. Their biggest strength was the ability
to mobilize foreign currency deposits and to swap these deposits. As
they were mobilizing dollar deposits, they were also considered
blue-eyed kids of the Government of Pakistan (GoP). Then came freezing
of foreign currency accounts (FCAs) in May 1998. Though, there was
restriction on withdrawal of money in foreign exchange, foreign banks
experienced, initially, large erosion in deposits. They also found
mobilizing local currency deposit difficult due to limited branch
network.

Foreign banks were, and still, competing mainly with
the five big banks. The private banks have intruded, to a large extent,
into their niche market. They also realized the fact that they could not
put up effective resistance against the local banks due to their limited
number of branches. Opening more branches was not only an expensive
proposal but also not enough to compete with the five big banks and to
face the ambitious branch expansion plan of the private banks. To
overcome this limitation, foreign banks are making huge investment in
technology, i.e. on-line banking, ATMs, credit cards, etc. However,
these services could only be used in urban areas, mostly. With the
gradual increase in the paid-up capital of private banks and depositors'
confidence in them, branch rationalization programme followed by the
NCBs and privatized banks, the feeling of inadequacy among the foreign
banks further intensified.

Some of the foreign banks have either already sold
their Pakistan operations to local banks or are actively involved in the
negotiations. The two banks which have already taken an exit are Bank of
America and Societe Generale of France (SG). Earlier, a very important
feature was conversion of Pakistan branch network of foreign banks into
locally incorporated banks followed by acquiring of large equity stakes
by foreign groups, particularly from the Middle East, in the local
banks. Faysal Bank of Bahrain was the first to convert its Pakistan
operations into a locally incorporated bank— Faysal Bank. A foreign
investors' group acquired Habib Credit & Exchange Banks (previously
branch network of BCCI) and renamed it, Bank Alfalah. Schon Bank was
bought by some foreign investors from the Middle East and given the
name, Gulf Commercial Bank. This was subsequently takenover by Pakistan
Industrial Credit and Investment Corporation (PICIC) and became PICIC
Commercial Bank.

As a result of merger ANZ Grindlays Bank of Australia
and Standard Chartered Bank of UK, now the two banks are operating under
Standard Chartered banner. The majority shares of Union Bank were
acquired by another group from the Middle East. Union Bank has also
acquired Pakistan operations of Bank of America and some business of
American Express in Pakistan. It has also acquired Pakistan operations
of Emirates Bank International of UAE.

It is very important to explore the motives behind
the above mentioned transactions, but first the SG deal. Al-Meezan
Investment Bank, established by Pakistan Kuwait Investment Company,
recently acquired commercial banking licence and the name was changed to
Meezan Bank. The new bank also acquired Pakistan operations of SG. An
interesting point is that SG sold its Pakistan's operations to Meezan
Bank but also acquired substantial stake in the bank. The point which
makes it further interesting is the declaration of Meezan Bank to
undertake commercial banking activities on the basis of Riba free
transactions only. It is rather unusual that a European bank has become
a partner in a bank which promises Riba free banking.

There has been no official announcement about the
takeover of Emirates Bank's Pakistan operations by Union Bank. However,
the sources in banking sector say that the deal has been concluded at a
substantial cost and formal approval from the shareholders of Union Bank
was acquired at a recently held extraordinary general meeting. It may
look a bit strange that Emirates Bank, which has been going strong in
Pakistan, makes such a decision. However, banking sector experts say
that Emirates Bank's decision is due to the shift in its policy which
envisages making the bank a strong domestic bank. It has already sold
its operations in the UK and India and it was expected they would also
pull out of Pakistan.

It is also important to look at the recently held
bidding for the sale of 51 per cent shares alongwith transfer of
management of United Bank Limited (UBL). Muslim Commercial Bank (MCB)
submitted the highest bid, almost double the amount offered by other
participants. Though, State Bank of Pakistan (SBP) has suggested to the
Privatization Commission to ask the bidders to raise the bids further,
it seems that MCB will ultimately takeover UBL. A question was raised,
why did MCB offered such a high price? The sector experts say, "MCB
has most probably submitted such a bid to make it difficult for others
to match the price."

Why should MCB be so keen in taking over
UBL? The
sector experts say, "The biggest attraction for MCB, in UBL, is its
overseas operations. MCB has already attained the status of the largest
private sector bank in Pakistan and now intends to make its presence
felt in the global market. Whereas Union Bank should be keen in
consolidating its operations after the takeover of Pakistan operations
of Bank of America, American Express and Emirates Bank." It must be
kept in mind that UBL's ultimate handing over to any bidder is largely
dependent on the formal clearance of the buyer by the Bank of England.
Therefore, the transfer of ownership and management of UBL to MCB seems
most likely.

It may be of some interest to compare MCB with Union
Bank in slightly more detail. MCB has a long history of operations and
successful restructuring after its privatization. It also enjoys
extensive and intensive branch network. Lately it has invested heavily
in technology to improve quality and range of its services which include
on-line banking, ATMs and MNET. Under the new management efforts were
made to recover NPLs and full provisioning against such loans.

Compared to
MCB, Union Bank has a rather bumpy track
record. The initial sponsors, Saigol Group, relinquished their stake in
the bank under a distressed sale. The new management, mostly comprising
of zealous and ambitious bankers, have yet to make a mark. It is true
that the bank is making a lot of investment to become the preferred bank
but has little control on expenditures. According to the annual report
for year 2001, bulk or almost total income was eaten up by operating
expenses and the bank posted a meager profit of around Rs 10 million for
the year.

It is often said that most of the banks listed in
Pakistan follow orthodox or conservative approach and they must come out
of this syndrome. However, the critics are often not able to
differentiate between orthodox and prudent approach in banking. It is
still the better to be a little conservative and make stable profit
rather than being adventurous and posting marginal profit or incurring
loss. Ensuring decent return to depositors and shareholders should
always be the key objective of the management of any bank.

ELIMINATION OF RIBA

According to an order by the Supreme Court of
Pakistan local financial institutions were required to eliminate Riba
from the system by June 30, 2001. However, taking into consideration the
quantum of work, the deadline was extended for one more year, to June
30, 2002. While the intellectual deliberations continued, the battle in
the court of law became more focused. Now, the court has ordered for
determination afresh in the light of contentions of the parties and the
observations. The financial institutions may no longer face the pressure
to re-engineer the system, at least for the time being. However, one may
raise a question, Is the court order more important or the Islamic
injunctions demanding elimination of Riba ?

The future deliberations must address key issues
like: 1) what is the real definition of Riba ? 2) Does the
prevailing system provides assurance against exploitation of borrowers
by the lenders? 3) Are the borrowers paying market-based rates? 4) Are
the fixed lending and borrowing rates only notional? There are host of
other issues which have to be dealt with. However, both the sides,
religious scholars and economists, must not enter into due diligence
with rigid stands. This is an academic discussion of the highest
importance — it deals with the basic teaching of Islam, Rizzaq-e-Halal.

PRIVATIZATION

The present government is making efforts to ensure
swift and smooth privatization of NCBs. This includes two tier strategy,
sale of remaining shares of GoP in already privatized banks and sale of
majority shares alongwith transfer of management of remaining NCBs.
There was plan to list the NCBs on stock exchanges first and then
off-load part of GoP holding, according to the market appetite.
Following this policy, National Bank of Pakistan was listed on local
stock exchanges and 5 per cent shares were offered to general public. As
the issue was heavily over-subscribed, the GoP decided to exercise
'green-shoe option' and off-loaded its 10 per cent shares.

As regards
UBL, the GoP decided to sell 51 per cent
shares alongwith transfer of management. The bidding was held and MCB
submitted the highest bid of Rs 8.5 billion. The next major transaction
on agenda is sale of majority shares of Habib Bank Limited (HBL)
alongwith transfer of management. Initially the GoP had the plan to
first enlist HBL on local stock exchanges and sell part of its holding
to general public. However, the plan has been changed. Now the GoP
wishes to make outright sale of the bank. The GoP has also offered to
sell its holding in Bank Alfalah.

KEY PLAYERS

Askari Commercial Bank
posted over one billion
rupee profit before tax and improved its payout for the year 2001
compared to dividend paid for the previous year. The Board of Directors
approved payment of 20 per cent dividend and issue of 5 per cent bonus
shares.

Bank Alfalah
may rightly term year 2001, 'another year of remarkable performance and
another year of consistent growth'. This is evident from a 47 per cent
growth in deposits, 24 per cent increase in advances, 31 per cent growth
in profit before tax and 44 per cent hike in profit after tax as
compared to the previous year. At the end of the year equity of the bank
also stood at Rs 1.361 billion, a growth of 51 per cent over the
previous year.

Faysal Bank
was able to wipe out its accumulated losses. Over the last couple of
years the bank not only managed to clean its slate but to also pay 10
per cent dividend. There was improvement in mark-up as well as non-mark
up income. The management was able to control expenses, though there was
slight increase in administrative expenses. There was also improvement
in basic earning per share — from Rs 1.53 to Rs 1.82.

Habib Bank
posted Rs 2.2 billion profit before tax for the year, almost double the
amount posted for the previous year. This was despite the fact that the
bank made provisions amounting to Rs 2.6 billion as compared to Rs 1.2
for the year 2000. Profit after tax of Rs 1.1 billion was more than
double the amount posted for the previous year. The bank managed to
curtail administrative expenses. There was a reduction in non-performing
loans. The bank has increased lending to SMEs. There was improvement in
overseas operations which contributed towards higher profit. Another
improvement was the increase in number of ATMS — 61 of its own and
over 100 machines through sharing with other banks.

Metropolitan Bank
posted Rs 742.7 million profit before tax as compared to Rs 567.9
million profit for the year 2000. Out of Rs 338 million profit after
tax, Rs 200 million were appropriated for issue of bonus shares. Rs 175
million bonus shares were also issued in year 2000.

Muslim Commercial Bank
is the largest private sector bank and the third largest bank of
Pakistan. The year 2001 was yet another year of achievements. The bank
posted over Rs 2.1 billion profit before tax and total dividend payout
for the year 2001 was 25 per cent.

PICIC Commercial Bank
(formally Gulf Commercial Bank) completed the first successful year of
operations since the acquisition of the bank by Pakistan Industrial
Credit and Investment Corporation (PICIC). The various structural and
financial changes introduced, yielded positive results. Some of the
indicators of improvement were, a hefty 153 per cent growth in profit
before tax and 79 per cent increase in deposits. The Board of Directors
approved issue of 25 per cent bonus shares and 40 per cent right shares
to further improve the balance sheet footing.

Prime Commercial Bank
was able to improve its earnings per share due to higher income, though
there was also increase in expenses. The bank posted Rs 241 million
profit before tax as compared to a profit of Rs 158.6 million for the
previous year. Out of Rs 152.6 million profit after tax Rs 122 million
were transferred to revenue reserve and the Board of Directors preferred
to skip dividend payment.

The Bank of Khyber
posted Rs 231 million profit after tax for the year 2001 as compared to
a loss of Rs 157 million for the previous year. One of the reasons foe
posting loss last year was the provision of Rs 310 million against NPLs.
By making such a provision the bank has cleaned its slate and the step
would augur well in the future performance.

Union Bank
posted a meager Rs 9.95 million profit before tax for the year 2001. A
closer look at the financial results reveals that out of an interest
income of Rs 597.5 million, provision against non-performing loans and
advances amounted to Rs 197.6 million. While interest income amounted to
Rs 597.5 million, non-interest income amounted to over one billion
rupee. An interesting observation was that as against a total income of
Rs 1,064.6 million for the year, administrative expenses were as high as
Rs 1,040 million.

The financial results of commercial banks for the
year 2001 seem good despite economic slow down, barring a few. However,
analysts say that the earnings for the year 2002 may come under pressure
due to shrinking spread. The central bank has been not only lowering
discount rate but also persuading the commercial banks to curtail
average lending rates. Since the demand for funds has not picked up
significantly, shrinking spread is adversely affecting profitability of
the banks. Meeting the enhanced capital requirement of one billion rupee
may not pose any serious problem for most of the banks.

DEPOSITS(Rs
in million)

Name

2001

2000

Askari Commercial Bank

41,200

30,359

Bank Alfalah

30,207

20,482

Bank Al Habib

24,697

17,823

Metropolitan Bank

17,902

13,136

Platinum Commercial Bank

3,991

6,416

Prime Commercial Bank

10,367

8,264

PICIC Commercial Bank

9,619

5,371

Soneri Bank

16,054

14,030

Union Bank

20,721

17,171

ADVANCES
(Rs
in million)

Name

2001

2000

Askari Commercial Bank

23,291

17,893

Bank Alfalah

19,131

15,242

Bank Al Habib

15,902

14,722

Metropolitan Bank

12,988

11,367

Platinum Commercial Bank

2,147

6,355

Prime Commercial Bank

6,853

6,794

PICIC Commercial Bank

6,330

4,746

Soneri Bank

10,199

10,931

Union Bank

13,869

13,346

OUTLOOK

Most of the banks have been able to make full
provisions against NPLs. The impact of September 11 incident did not
appear in first quarter reports. The real impact can only be quantified
after half-year results are announced.

The demand for funds by the private sector has not
increased despite reduction in lending rates. State Bank of Pakistan has
been consistently reducing T-Bill yields and discounting rates which
have reduced the spread. Therefore, profits of banks are expected to
remain under pressure despite reduction in corporate tax rate.

While further reduction in lending rates seems
improbable. The analysts forecast for slow and gradual increase in
interest rates during October-December quarter this year. That is the
time when funds are needed the most by textile and sugar industries.

Analysts hint towards more foreign banks leaving
Pakistan. These include Doha Bank, Mashriq Bank, IFIC and Rupali Bank.
Operations of some of these banks may be taken over by local financial
institutions and closure of a couple of banks seems certain, if local
buyers do not come forward. The three foreign banks, namely Standard
Chartered, Citibank and ABN AMRO are expected to get further strength
mainly because of the diversified range of their products and services.